How to face uncertainty and adapt to Individual Income Tax rule changes in China?
With the continuous boom of the People’s Republic of China (PRC) economy, not only more and more seconded foreign employees start to work in China, or extend their work permission, but also young generation with foreign citizen becomes entrepreneurs and starts to run their own business in China. Those of us that work in HR, payroll, finance, and tax areas and each foreigner himself/herself in the PRC have been urged to catch up with newly announced Individual Income Tax (IIT) regulations since the end of last year. A lot of supplementary and detailed rulings were quickly rolled out following the new PRC IIT law and its implementation rule set forth in the second half year of 2018. How do you plan to deal with each specific IIT issue in this year without a clear understanding of detailed IIT rulings? Simply by surfing the internet and calling the tax hotline (12366) of your city? We believe this may not be enough.
The employers located outside China may navigate through a difficult path when seconding foreign employees to work in China where its IIT rulings are constantly changing recently. Normally speaking, immigration, tax, social security and foreign exchange control of host countries are major factors impacting an overseas secondment arrangement. The employer outside China must ensure the seconded individuals to start working in China timely, legally and their relevant secondment arrangement is compliant with local tax rulings as well as to ensure the overall secondment costs are not high.
For short-term business travelers who would spend for no more than 90 days in China, they are required to apply for M visa rather than L visa. Unlike L visa granted for the purpose of social communications and visit, M visa is granted to those who would take business and trading activities in China. M visa is also called short-term work visa. For those who would spend for more than 90 days in China, they need to apply for Z visa (known as work visa). The good news is that expatriates can apply for Z visa from their home countries since year 2017. With these in mind, are you making the right application towards different types of visas for your seconded employees?
For example, if your local Shanghai entity is going to hire a localized foreign employee who needs to move from another city to Shanghai after accepting your offer. How are you going to alter his work and residence permit to Shanghai? Does he/she need to go back to his home country to start a new round of immigration cycle? The answer is no. If you know how it works, it will definitely ease the administration burden and not delay his/her onboard date.
For the first time, the new IIT law consolidated four different types of incomes, i.e. salaries and wages, independent incomes, incomes from author’s remuneration and royalty incomes received by PRC tax residents into one annual integrated income subject to aggregate IIT rate(s). While for the said incomes received by Non-PRC tax residents, they are still subject to PRC IIT under different income categories. Except for the said incomes, other incomes like operating incomes, interest incomes, dividend incomes, capital gains from rental income/property transfer and occasional incomes, are still subject to PRC IIT under different income categories.
The comprehensive income received by PRC tax residents is subject to PRC IIT on annual basis; If there is a withholding agent, the relevant PRC IIT should be calculated and remitted to in-charge tax authority by the withholding agent on monthly basis or upon a tax event occurs. If there is no withholding agent in China, these individuals are required to file PRC IIT returns by their own. An annual tax clearance should be performed within the period from March 1 to June 30 of the following year if a tax adjustment is required.
Unlike IIT filing is proceed jointly sometimes in other countries/jurisdiction, the PRC IIT return is filed individually no matter on monthly basis or when the annual one is submitted. As a reference from other foreign countries, i.e. SSN for US citizens and tax file number for Australian citizens, the Chinese identification number (for Chinese nationals), passport number (for foreign nationals), home visit card number (for Hong Kong and Macau residents) and travel permit number for Taiwan residents) are used as individual tax filing number when filing PRC IIT returns through tax on-line filing system. It becomes a unique and unchangeable number by which the Chinese tax bureau would easily supervise the tax filing status of each individual.
The new PRC IIT reform gave more lenient treatments to foreign employees working in China now. One key change is the residence rule changes from ‘Five-year rule’ to ‘Six-year rule’ effective from January 1, 2019. Disregard of how long they have resided in China prior to year 2019, 2019 is the first year of the ‘Six-year’ calculation cycle. The other change is about 'one-full year tax resident' rule. Foreign employees are considered as one-full year tax residents in China if their physical presence days in China exceed 183-day threshold in a calendar year. Keeping these changes in mind, will you review the current secondment arrangement for your employees and see if any changes needed? If they have to be seconded to China, are you aware of the potential double tax issues from improper secondment arrangement? It is suggested that you have a conversation with your employees to remedy their potential tax costs arising from secondment arrangement in China.
The dual employment and split payroll arrangements have been implemented in China for many years and never been forfeited thus far. It is not compliant if only China-paid portion to your foreign employees are reported for IIT calculation purposes in China. The correct way is to declare both portions in China as both of them constitute China-sourced income. For those who have regional/non-China duties and responsibilities, both of their incomes paid in and outside China should be reported prior to year 2019 and then, a time-apportionment calculation formula at tax level is available. Effective from year 2019, the time-apportionment calculation formula at income level is applied which is closer to the 'income exclusion' rules implemented in other countries/jurisdictions.
The China social security law requires foreign employees who legally work in China, i.e. obtaining work and residence permit, should make Chinese social security contributions. The contribution base and ratio vary from city to city. In practice, its implementation has not been strictly followed at city level. For example, no fine or penalty is imposed if the employers in Shanghai failed to make any contributions for their foreign employees working in Shanghai while making Chinese social security in Beijing is compulsory. For budgeting purpose, you have to understand different practices of social security contributions in different cities before assigning your foreign employees to China.
Furthermore, you also need to know more about which countries have signed the ‘totalization agreement’ with each other to explore the opportunity to waive social security tax in host country.
Most of seconded foreign employees prefer to continuously maintain their social security contributions in their home countries rather than host countries. An allocation of certain portion of their salary income could fulfil this purpose in home countries. That’s why dual employment and split payroll are always applicable in modern world, not only for non-RMB salary payments but also for social security maintenances.
Sometimes, the home-country employer would cross-charge relevant compensation cost to the host-country employer in China as the latter one is the economic and beneficial employer. Such remittance is made at the company level. Under the strict foreign exchange control implemented in China, theoretically speaking, it is feasible for cross-charge as long as relevant PRC IIT has been paid. However, due to the strict foreign exchange control implemented in China, there are a lot of processes you need to undergo with the in-charge tax bureau and the remitting bank especially when dealing with a backlog charge for past months or even past several years. Have you planned ahead on how to make cross charges at the beginning of global assignment and what’s the frequency?
Furthermore, at individual level, an individual may purchase or sell foreign currency up to USD 50,000 respectively per person per year. It is allowed to exceed such limit for salary income once its relevant PRC IIT has been paid. With the PRC IIT payment certificate, a foreign individual is permitted to convert after-tax salary from RMB to USD and remit out of China.
In order to make a smooth transition from old IIT law to the new one, the preferential tax treatments on annual bonus and non-taxable benefits have been retained for another three years, i.e. from Jan 2019 to Dec 2021. Before the end of the transition period, annual performance bonus is still subject to the preferential tax treatment, that is, it is not required to be combined into annual comprehensive income and the applicable tax rate of which is determined by 1/12 of the total amount of annual bonus. If your foreign employees become one-full year tax residents in China and receive such annual bonus payments for this year in February 2020, the said treatment is still applicable.
During the transitional period, foreign employees may opt to enjoy current tax exemption treatment (i.e. housing subsidy, language training subsidy and children education fees, home leave, meal and laundry) mentioned in the old tax Circular No. 35 issued in 1997 if certain conditions are met. If you have never heard of such exemption rules in the past, why don’t you best utilize it for the last chance for your foreign employees working in China?
In today and tomorrow’s constantly changing world, if you cannot adapt yourselves to face those uncertainties, you will bring some troubles, pains and extra costs to your organizations. We are compliant if we follow the tax rules. We can alleviate a lot of surprises and financial cost more than compliant if we closely catch up with the rapid tax rule updates. We should have a good process at the beginning of seconding someone to go abroad and during the process, we need to think fully, act quickly and finally achieve more.
Please feel free to contact me if you want to discuss any of the issues raised or need our tax services.
African nations provide some of the greatest opportunities to multi-national organisations. With this opportunity comes complexity, and it is imperative that those managing employee mobility into and out of the region understand the specific differences. Through understanding these differences, mobility professionals can the increase speed of talent deployment and the return on investment for their organisations.
Rich in natural resources, with a comparatively young workforce, booming populations and rapid urbanisation that is creating incredible mega cities, are all factors that are serving to accelerate more African nations to become powerhouses of the global economy.
These factors all contribute to growing economies and markets that are ever more important on the global stage. There is no doubt about it, Global Mobility in Africa is on the increase. Getting talent into and out of Africa has long been a feature of certain sectors (natural resources), but it is an increasingly important part of global mobility and workforce plans across more and more organisations.
Africa is an amazing place. Geographically, its longest coastline is in Mozambique and it has the world’s largest hot desert the Sahara, in North Africa (3.3 million square miles), roughly the size of the USA. It also has the longest river, the Nile, which has a drainage basin in 11 countries and which stretches 6,650 kilometres from Burundi in the South to Egypt in the North. Africa is the second largest land mass and the second most populated land area on earth (6% of the earths surface and 20% of its land area).
The continent has 55 countries with an estimated population of almost 1.4 billion people (2017). This population is expected to reach three billion by 2050. Languages spoken in Africa include, amongst others, Arabic (by 170 million people), English (130 million), (Swahili 100 million), French (115 million), Portuguese (20 million) and (Spanish 10 million).
Africa is the world’s fourth largest oil producer (Nigeria produces 2.2 million barrels a day), and has 30% of the world’s natural resources. Africa still has the world’s largest remaining reserves of precious metals i.e. gold reserves 40%, cobalt 60% and platinum reserves 90%. Although not the world’s largest deposit, Zimbabwe has a sizeable store of lithium reserves.
The continent and its nations have vast potential and Africa is, as a result, very attractive from a business perspective. The movement of people as a result of this economic development across the continent is of particular interest to Global Mobility professionals.
Together with Africa’s vast natural reserves and its economic acceleration, it is reasonable to foresee that there will be vast economic development across the region, which will bring yet more increased trade activity, industry and foreign investment. Trade and industry will naturally result in further increases in people movement, as skills and professional services are procured to satisfy needs.
It’s certainly not easy to generalise across 55 countries, but some areas mobility specialists will want to keep sharp in focus could include:
Immigration: The immigration process can be less predictable than elsewhere and the timing and documentation requirements can be more case dependent. For this reason, it’s important to start this process as early as possible. In certain countries (for example in Nigeria and Ghana), quotas are in place and this can involve a separate process. Special rules may also apply to different types of employer, such as NGOs and Oil and Gas companies.
Cost: Employers are often surprised by the cost of mobility into Africa. Employees need different types of support and benefits with security, healthcare and housing being more important and costly than often expected. Assignment costings after liaison with benefits and destination services with specific local knowledge are must!
Tax:It is essential that the concept of an assignee/expatriate be fully understood so that the tax and other pitfalls are not missed entirely. We often find that tax liabilities are missed completely, simply because nobody identified that the entity in question had in fact engaged the services of expatriates/ assignees. The major cause of this, in our experience, has been misunderstandings around what precisely constitutes tax residence in a particular tax jurisdiction.
The tax systems across Africa, with a few exceptions (the most notable being Angola) are all on a residence, as opposed to a source, basis of taxation.
The obvious danger here is that from the time of becoming a SA tax resident, that person’s worldwide income falls to be taxed in SA and the expatriate tax and/or benefits, which may have been applicable up to that point fall away and become non-applicable. This change over point is very often missed, thereby creating a multitude of complexities including penalties, interest and stress.
Each country in Africa has its own specific legislation and requirements concerning its ‘physical presence’ test. The SA presence test is an annual test over a multiple tax year period, and it effectively takes a number of years to become physically tax present in SA. Many countries in Africa have a much shorter time period for physical presence. In many cases, tax residence commences after an initial 183 days.
The movement of employees into, across and out of Africa, as can be seen, clearly does not come without its complexities. We recommend that professional assistance and advice be obtained prior to the deployment of assignees into the region.
When I first entered the tax profession at the turn of the millennium, mobility tax was known as expatriate tax. That language has now moved on to mobility tax, but the concept of expatriate or expat tax breaks remains. In short, these are tax exemptions that apply in different countries to globally mobile employees (or expatriates).
Awareness of these tax breaks is really important for those involved in, and managing mobility. There can be very substantial tax savings, often savings for the employer under tax equalisation, so it is vital they are not missed.
They can be very valuable. This relates in part, to how tax equalisation works.
Tax equalisation is an approach that seeks to neutralise differences in tax rates between countries to promote employee mobility. The employee usually agrees they will continue to pay the same level of tax as their home country. This may be through a hypothetical taxes deduction. In return, the employer then agrees that they will settle the actual taxes due.
As the employer is settling the taxes due, the compensation becomes what is known as ‘net.’ Tax rates that apply on net compensation are considerably higher because paying the tax for an employee is in itself a benefit on which tax is then due. As a result, ‘grossed-up’ tax rates apply.
The top rate of income tax in the UK is 45%. If this has to be grossed up, then the tax rate becomes 89%. As a result, £89 of tax due by the employer would be saved if £100 of income/compensation can be removed from tax using an expatriate tax break.
If £50,000 of compensation is removed as a result of an expatriate tax break then £45,000 of income tax saved for the employer. If you have 10 employees to which this applied over 5 years, the savings could be £2.25 million! The savings could be even larger if social security was also taken into account.
The rules differ from country to country so local tax expertise is a must. There are specific tax breaks that apply to globally mobile employees. There are also other tax breaks that were not designed for globally mobile employees, but they do apply to them.
The tax breaks could apply to all forms of globally mobile employees including long term assignees, short term assignees, local hire employees, business travellers, Directors, commuters and those with regional or cross border roles.
The rules and conditions really do vary location by location. Having reviewed the relevant rules across the world, I would suggest they fall into one of the following groups.
Local expert tax assistance is vital because although there are overall themes, the rules and process are always country specific. As a result, it’s necessary to understand what procedural steps there are to consider, to ensure the tax breaks apply. There may also be particular claims that have to be made on an employee’s local income tax return.
In short term assignments, there can often be ongoing tax considerations in two countries. As a result, care needs to be taken not to focus exclusively on one location only. What is tax efficient in one country may lead to a worse impact in the other country so it’s important to keep an eye on the overall cross border tax position.
Taxes due by employers for a globally mobile employee can be a very significant part of the overall cost of the assignment or work arrangement. Utilising expatriate tax breaks is key in optimising the overall costs.
It’s important for mobility professionals to be aware of these tax breaks to ensure the business doesn’t bear unnecessary extra costs. Equally, it’s key to explore early on the requirements and procedural aspects with the support of local tax advisors so key set-up steps are not missed.
Today we cover US Nationals and Mobility. Without doubt, given the huge size of the US economy and the US talent pool, US Nationals are probably the most populous of all globally mobile employee nationalities. However, as a result of the US tax system, they can probably also be the most challenging from a tax and payroll perspective. The issues discussed here apply to mobile employees but, can also apply to US nationals who are hired on local employments too.
It’s important for those managing global mobility to understand why US Nationals are different and potentially more challenging so they, and the business can be prepared for additional complexity and plan ahead.
The issue is one of multiple tax systems or double taxation, which is constantly at play. Almost all countries provide a temporary fix through which the link to their tax system can be temporarily broken. This results in tax and payroll for long term assignments becoming focused primarily on one country.
The US tax system for US Nationals and permanent residents is not like this. US taxes will always need to be considered. By US taxes, I mean US Federal taxes, and then on top of that we also have State and City taxes. US tax returns are usually required every year regardless of where the employee lives and works.
For those managing mobility and deploying or hiring US Nationals, they need to recognize that the employee will always have at least two tax systems to consider. As an employer, this results in more payroll, compensation and policy complexity to work through.
Seeking tax advice in the US and the host country location prior to the move can prevent unpleasant surprises in both tax jurisdictions. Certain parts of the world have NIL or low income tax regimes, for example in Dubai. Mobilising a US National to work in Dubai doesn’t result in the tax free status it can for others. This is a key point.
Although this article references US Nationals, the issues discussed actually impact a wider population.
A. Tax Return Filings
In general, all US citizens and GCHs (even if they never lived in the US), are required to file US Federal income tax returns annually. They are required to report their worldwide gross income regardless of the source or location of the payment. With the new tax legislation introduced for the 2018 tax year, there is no minimum income threshold for filing.
A US person is required to file a US income tax return even if the individual permanently lives in a foreign country, or temporarily resides in another country, and their wages are within the FEIE (foreign earned income exclusion). This filing requirement applies whether there is a US tax liability or not.
The FEIE allows the taxpayer to deduct $103,900 (for 2018 adjusted to inflation each year) of foreign earned wages from being taxed on the US Federal income tax return. However, in order to take this exclusion, a person must file a US income tax return.
B. Reporting Requirements - bank accounts
US citizens, US Tax residents and GCHs are required to disclose the highest balance(s) of their non-US financial accounts (i.e. foreign bank accounts) to the Department of the Treasury when the aggregate value of their bank account(s) exceeded US$ 10,000 during the calendar year.
The Report of Foreign Bank and Financial Accounts (FBAR), also known as FinCEN Form 114 is required whether the individual owns the account (solely or jointly), as well as if you have signatory authority on accounts where you are not the account owner. This reporting applies to children as well as adults.
The signatory authority scenario can arise simply because of responsibilities the employee has as part of their role for their employer.
C. State/Local Income Taxes
Depending on the State and Local tax residency, the employee (and therefore the employer for payroll purposes) may also continue to be subject to state/local income tax while on assignment. Influencing factors include the duration of the international assignment and connections maintained in that state (active local bank accounts, voter registration as well as intentions to return to that state, etc.). Tax laws vary by state and local tax jurisdictions. A tax advisor can review the specific situation to determine if an employer will need to continue withholding state/local taxes while the employee is working overseas.
All US persons, regardless of where they are living, may be subject to tax filing requirements. These obligations can exist even if the individual has not obtained a US passport, or even set foot within the US. The US Internal Revenue Service (IRS) is aware that many US persons are not compliant with the filing of US Federal Tax Returns and the reporting of FBARs. In many cases, people are simply not aware of their US filing requirements, which places them at risk of being seriously delinquent in their US filing obligations with exposure to substantial penalties and interest.
As at least two tax systems will inevitably be at play, there will be additional complexity. Where this complexity is created as a direct result of a globally mobile work arrangement, or assignment, we see that these issues over time, will result in the employer becoming involved. Where the employee is tax equalised, it is in the employer’s best interests to manage US nationals carefully at the beginning for the following reasons.
It's important to understand that US nationals are different because their tax system is different. This means the taxation of their compensation and the related tax reporting requirements are also more complex.
“I never stay more than 183 days in other countries. I do not have any tax obligations there.”
“Our employees never travel for more than one or two months to other countries. Taxes abroad? This is no issue for us.”
Often, the focus is on counting the working days in other countries. If below 183 days, then no taxes apply. However, this approach is incorrect. There is much more to the 183 day rule.
The rule relates to Double Taxation Treaties (DTTs). DTTs are Treaties determined between countries that exist to prevent double taxation. They can override domestic tax rules, and are important in the world of global mobility, as they provide a mechanism to prevent double taxation and simplify compliance.
Where employees live in one country and work in another, the first thing to check is if a DTT between the two countries exists. If not, there is no 183 day rule to consider. Instead, national rules and domestic tax laws of the relevant countries apply.
If a DTT exists, then it is necessary to first establish the country the individual is resident in under the DTT, this is known as a Treaty Residency. For people who are only tax resident in the home country and not in the country they work in, this is generally quite simple. In most cases individuals are treaty residents in their home country. Once the Treaty Residency has been established, the 183 day rule can be reviewed.
An employee lives with his family in Italy. During the week he works in Germany where he has a flat. He spend his weekends and holidays with his family in Italy. In January 2019, he was on a business trip in Italy for two weeks. In which state is the salary for this business trip taxable? The employee is tax resident both in Italy and Germany under domestic law. Under the Italian/German DTT they are treaty resident in Italy. As the employee worked in the same state in which they are treaty resident, the 183 day rule does not apply. The business trip is taxable in Italy.
Now, let’s assume individuals work in a state in which they are not treaty resident. In these cases, salary relating to working days in the other country is not taxable there, providing all of the following conditions are met:
If all three conditions are met, the salary is not taxable in the country in which the work was performed. These are general rules. It is important to review the relevant DTT. General principles of the 183 days rule are similar but the detail can differ between DTTs. Let’s review the conditions individually.
1. The individuals stays less than 183 days in the state of work
Depending on the DTT, the 183 days can be in:
The last option is quite tricky for HR departments. Manual counting of days is time consuming. Weekends and even holidays in the country of work have to be counted.
An employee from Germany was on business trips in China during 2012 and 2013. In both years he stayed in China for 95 days (August to December 2012 and January to May 2013). The employer has no office and no PE in China. HR reviewed the China/Germany DTT in 2012 and 2013. They established that the salary referring to working days in China was taxable in Germany, because in both years, 183 days in China were not exceeded.
The same employee was on business trips in China in August to December 2018 (95 days) and again in January to May 2019. The employer still has no office or PE in China. Is the answer the same?
No. The Germany/China DTT has changed. Now, the 183 days may not be exceeded in any twelve month period. As the employee stayed in China for more than 183 days in the period August 2018 to May 2019, the salary relating to working days in China is taxable there.
As you can see, it’s important to always check the relevant and current DTT and not rely on experience with DTTs of other countries or from prior years.
2. The remuneration is paid by or on behalf of an employer, who is not a resident of the work state.
At first, this condition appears easy. If the employer has an office or establishment in the country of work then salary is taxable there, if it is borne there. Is that true?
No. In some countries an ‘economic employer’ approach applies. This approach reviews if the legal employer corresponds to the economic employer. In general terms, the economic employer is the entity into which the employee is organisationally integrated and, which bears the salary costs of the employee. Costs borne by the entity where employee is working usually results in taxes due in that country, but it’s not always that straightforward.
From January 2018, an employee was posted from Italian HQ to a subsidiary in Germany for 5 months. His family stayed in Italy. During the week the employee lived in a flat in Germany. Although the employee worked for the German subsidiary, the salary was not charged to the German company, but was borne by the Italian HQ. The Italian HQ does not have a PE in Germany.
HR of the Italian HQ established that the employee stayed in Germany less than 183 days and had no German employer. During an audit of the German subsidiary, the auditor found out that the employee was organisationally integrated into the German subsidiary and, that the salary should have been charged to the German subsidiary in accordance with special corporate tax principles known as transfer pricing. Are there any consequences for taxation of the salary?
Yes. The taxation of the salary now has to be reviewed on the basis that transfer pricing rules were met. Following transfer pricing rules, the German subsidiary should have borne the salary, with the consequence that the German subsidiary becomes the economic employer. Salary relating to working days in Germany is taxable there.
3. The remuneration is not borne by a PE of the employer in the state of work.
It is often thought that a PE is something that has to be formally or deliberately established or founded in another country. It is not. If special conditions are met, companies can have a PE in another country.
In November/December 2018 a technician, living in Germany, works for 8 weeks on an installation project of his employer in Poland. The project started in March 2018 and was scheduled to finish in February 2019. Due to illness of various team members, the project was finalised in April 2019.
The Poland/Germany DTT states an installation results in a PE if the duration of the installation exceeds 12 months (the reason is not relevant)
Although the reason for exceeding the 12 months period for the installation was the illness of employees, the German employer now has a PE in Poland. The salary relating to the working days in Poland was (respectively had to be) borne by the PE. The salary is now taxable in Poland.
The 183 day rule is not as easy as it may first seem. Understanding the commercial set up in a country and the specific recharging structure of a globally mobile employee is key. A detailed review of relevant legislation and facts can then follow and this is key to managing employee related risks.
It’s important to:
Trailing compensation is an important area for those involved in employee mobility to understand. There are payroll reporting and payroll taxes obligations that cannot be met without the identification of trailing compensation.
Those involved in the employee mobility process are well placed to identify and therefore ensure compliance and avoid related employee pitfalls.
Tax rules around the world generally need a trigger for a country to tax an employee’s compensation. One logical trigger is physical presence and tax residency - the employee lives in a particular country and should therefore pay tax there.
Another trigger is that the compensation was earned when the person was taxable there (but is no longer resident there). If this compensation is then paid after leaving the country this is what’s known as 'trailing compensation' - trailing because it is paid after leaving but still relates back to a period of residence.
The concept of trailing compensation can in theory apply to any type of compensation that meets the definition above but the usual examples are bonuses and incentives (such as shares awards).
The complexities arise in two main areas - payroll and compliance and then around tax impacts on the employee.
Payroll reporting and tax withholding in countries is often closely connected with whether or not the relevant compensation is taxable in that country. If the compensation is paid in another country (which could be the current payroll and employee location) then there can be a disconnect between where the payroll reporting and deductions have been done and where they should have been.
Example (UK to US but principles could apply to any countries).
Payroll compliance in the UK is probably not correct. This is an area that can often be reviewed in payroll audits. It is bad enough that one case results in payroll taxes underpaid that result in employer penalties and interest. However, unless a process to systematically address the issues is implemented then many employees, in many countries with many awards over many years can quickly build up to a very significant global employer compliance risk and problem.
Let’s continue with the example above. The issue we have here is the employee only received $45k after US taxes as $30k was deducted as US payroll taxes but UK taxes are also due.
As no tax was retained under UK payroll the UK taxes have to be paid through the tax return process. That UK tax is due on 31 January 2020 and now we have a problem.
The UK tax due is at 40% or another further $30k - so by 31 January 2019 the employee has had to settle, or had deducted at source, $60k of a $75k bonus meaning they only have $15k left and have effectively paid a 80% global tax rate! This would usually result in a less than happy employee.
The bonus which originally most likely was intended as a motivational reward to the employee, recognising their contribution in 2018, now no doubt becomes a source of agitation and frustration.
Eventually the position will be corrected as the US tax return for 2019 is filed and claims to prevent double taxation are made. It could be well into late 2020 before a refund of US taxes is made to partially, or wholly, refund the US taxes withheld.
You can see that in the relatively simple example above we have compliance and employee issues in two counties that can carry on for well over a year after the payment date of the bonus.
Share options and share awards can have a much longer award life. It’s not that unusual that these kind of awards have three or even five year lifespans. Consequently, if an employee has worked in three or more countries during the life of the award then on the exercise of the options, or the transfer of any shares to the employee, there may well be country employee payroll tax reporting and deduction obligations in three countries. This is a real challenge for the employer to analyse. In addition, the employee has to somehow understand how this all impacts their global tax rate and tax payment timings and income tax return reporting’s in respect of the shares.
Trailing compensation is commonly an area for fiscal authority focus in payroll audits. It is so because it is a complex area and is not easy to ensure compliance. You can see from the above example that the issue can lead to a lot of extra complexity for the employee too.
So what can be done to manage the compliance and mitigate complexity for employees?
Trailing compensation is a potentially complex area from a process and technical perspective that has clear implications for employer compliance and employee reward.
Identification of the relevant cases is the starting point. Those involved in global mobility play a key role in identification and therefore the ability of the organisation to have the right resultant processes.
Alongside the assignment policy, the tax equalisation policy (the documentation of the tax equalisation approach) is a key enabler of employee mobility. The policy usually sits as part of the suite of Reward or Compensation and Benefits policies in an organisation although the Tax Department too can be an owner.
As tax equalisation involves the management taxes due by the company the policy plays a significant role in the financial and compliance management aspects of a mobility programme. These policies drive compensation entitlements and reward and, as such, heavily impact the employee experience too. Given this, it is essential for those involved in global mobility to understand these policies and identify where they aren’t working or require development.
Not all organisations will have a policy in place. This article may prompt thoughts on whether your organisation needs one.
Fundamental to understanding tax equalisation policies is the concept of tax equalisation. Tax rates and rules between countries differ. As employees become globally mobile they can trigger taxes in other countries. As they do this, two things happen:
To manage this complexity companies often adopt the philosophy of tax equalisation which ensures that the employee remains responsible for broadly the same burden of taxes as if the employee carried on working only in their home country.
A number of policy approaches and practical details are required to underpin this approach and those items are usually found in a tax equalisation policy. The policy helps take the philosophical and conceptual to the practical.
The policy is there to support the delivery of a tax equalisation approach. It should answer important practical questions and provide guidance to negotiate ambiguity. These are really key because tax equalisation creates new deliverables, obligations and responsibilities. Each of these requires clear inputs and guidance on a number of important aspects.
Tax equalisation approaches very often require the appointment of objective tax advisors who will need detailed guidance on a number of aspects. Tax is a technical issue and the policy usually has to get into some detail around this. For this reason, tax equalisation policies are often closely developed and maintained with external specialist mobility tax advisor support.
Tax equalisation policies can apply to any employee group where cross border taxation is an issue. This means it applies to short term and long term assignments but also to commuters and business travellers.
I've also seen tax equalisation policies, or frameworks at least, developed for regional roles and board members where the seniority of roles results in taxation in more than one country.
Tax equalisation approaches can even apply in the same country, the US for example has different tax rates in different states and cities. If at the request of the business the employee has to travel to new cities or states these can materially impact their personal tax liability and with it the payroll obligations of the employer. Some organisations will therefore have a tax equalisation policy of some sort to cater for this State to State scenario.
This is a really key point because it really does depend on the business and the size and scale of employee mobility.
It’s really important to note that the level of detail that applies in different organisations and to different groups can differ. This is closely connected with the culture of an organisation as well the level of detail that is practically required.
A lack of detail isn’t necessarily a bad thing. High level guiding principles can be interpreted and applied to new situations. Tax rules are after all constantly changing and updating and maintaining a policy that handles every change can be really cumbersome.
On other hand, detail is generally desirable as the number of employees who are tax equalised increases. The volume of deliverables under the policy for example hypothetical tax calculations, tax returns and tax equalisation calculations can quickly grow. This can be across multiple countries and tax systems. In these scenarios more detail is essential otherwise mobility professionals will spend a lot of time on interpretation and administration. Documenting and agreeing global and local tax positions under the policy can save a lot of time and deliver a consistent employee experience.
As covered above, the level of detail is usually driven by the corporate culture and approach of an organisation along with the size and scale of the employee population to whom tax equalisation applies. That said, there are some common items it is useful to include.
Below are 10 key areas that are often necessary to include.
It is worth noting that every £,$,€ that is recognised as a deduction for hypothetical taxes directly increases the tax liability for the employer. The policy plays a key role in tax cost management,
A tax equalisation policy is key in enabling employee mobility in a compliant and cost effective way. Often the global mobility professional is in situations where they have to explain how their company approach works either to the business or to employees. An understanding of the approach is vital to help the business manage risk and cost and ensure the employee experience from a compensation and reward is equitable and holds no surprises.
Perhaps of all the ‘tax’ compliance related risks those involved in mobility come across the Permanent Establishment (PE) risk is maybe the least well understood. This article should help in changing that.
For a number of reasons, PEs are ever more in focus at tax authorities at local and international levels and therefore represent a high risk. In addition, more informal and fluid employee mobility that is a feature of the times now can result in more PE risk.
Those involved in global mobility can play a key role in the identification of the issue. As such, a high level understanding is key to enable global mobility professionals to assist organisations in the successful management of related risks.
Before we get into what PEs are let’s look at the backdrop against which they may appear.
Those involved in employee mobility will be well aware that globally mobile employees can result in changes to tax related compliance obligations for the employees and for the organisation. As examples, employees may have changing or new tax filing and payment obligations and the organisation itself may have new and more complex payroll deduction and reporting requirements.
Obligations for the employer organisation can exist in the home and host location organisations. Although the home and host organisations or entities may well belong to the same global group they are usually regarded as being independent by tax authorities. These entities have obligations of their own to tax authorities under corporate taxes. Just as employees can trigger tax implications through their presence or residency in a country so can these corporate entities.
The PE issue relates to the home employer organisation. In the context of global mobility it is a taxable presence of the home employer (for corporate taxes) in the host country caused by the presence and activity of the employee or a group of employees over time.
In theory, any kind of employee mobility scenario can give rise to a PE risk in the host country.
That said, a lower risk scenario is where an employee is sent from one entity (home entity) on a formally documented secondment/assignment to the host entity and all the duties that then follow are performed for the host entity only. Not all employee mobility fits this scenario. As a result, the follow types are among those that require attention.
Unexpected costs, management time and effort and reputational risk can follow when employees create a taxable presence of the home employing company in the host country.
Where this occurs, the employing company (home employer) can (unknowingly) become liable to foreign corporate taxes in respect of the profits that relate to the overseas activity. In addition, foreign tax filings can be triggered and require attention.
Unfamiliarity with local tax law and compliance requirements in the foreign country can make this a difficult process to manage (or to even identify in the first place).
The cost of non-compliance with corporate related tax obligations in the foreign country can become significant with the addition of interest on unpaid tax and related penalties. These costs can quickly rise again if there are a number of years or even multiple countries involved. As well the tax dues, corporate taxes related registrations, tax returns and other filings can also be required.
Alongside considerable management time and energy that is then required to put things right there can also considerable professional advisor costs related to bringing the compliance up to date. At the risk of stating the obvious, this can all come as a nasty and costly surprise to the business.
The existence, or not, of a PE in a foreign country is often difficult to determine as the rules are complex and their interpretation is frequently subjective.
Consideration should be given to the risk of creating a foreign taxable presence whenever employees are globally mobile. Issues to be considered should include:
Situations which may give rise to a taxable presence in a host country when employees are globally mobile include:
The phrase “the ability to conclude sales contracts” is often difficult to interpret. The concept of ‘concluding’ in this context is not limited to the act of just physically signing a contract but also includes the negotiation of contract terms leading up to the formal signature. This can be the case even where the contract is referred back to Head Office for ‘rubber stamping.’
If a foreign taxable presence is created, it will then be necessary to determine the profits on which corporate tax is payable in the foreign country.
In recent years, many countries have developed steps to counter international tax avoidance which will make it more difficult to avoid the existence of a taxable presence in a foreign country.
PE isn’t always the best understood risk in the area of employee mobility – a high level understanding, however, is a must.
Those involved in global mobility are often in a unique position to spot that the issue may exist in a particular work arrangement or project. Once identified, close collaboration is required with the Finance and/or Tax department of the organisation to understand how to assess and best manage.
Proactive management is key. With careful review and planning, it can be possible to avoid a PE in a particular country through reviewing what duties are performed and not performed there. Equally, if a PE is to be created then getting ahead to enable timely compliance can bring with it much reduced costs and management attention than when compared to a non-compliant scenario.
Three key steps to keep front of mind:
Net to gross calculations are often referred to when mobility interfaces with Finance and/or payroll.
As these terms are not part of everyday language there can be a bit of mystery around them. That said, they are important concepts to understand to enable the business to make the right provision or accrual for the costs of globally mobile employees. After all, nobody likes cost surprises. Equally, most tax authorities require reporting through payroll or tax returns of the gross compensation. So for compliance it’s important to know the gross amount.
Net to gross calculations are also important from a compensation and benefits perspective.
Critical to understanding this area are some crucial terms - and net Gross is the amount of pay before taxes are deducted. Net is what's left after taxes are applied/deducted. From a finance perspective the gross is the cost to the business and the number that probably needs to be reflected in payroll reporting.
When organisations look at compensation in the context of employee mobility two key concepts have to be thought through.
As a result of thinking through these concepts organisations often decide that the employee should receive a net pay entitlement. In other words, a certain amount of compensation after taxes (a net pay scheme).
The net to gross calculation is a sort of backwards tax calculation.
Rather than starting with gross pay and deducting taxes, the starting point here is the net pay. For example an organisation may establish the employee should receive EUR 4,000 a month after taxes. To process the payroll and understand the real cost they need to understand real gross compensation. The net to gross calculation establishes what gross would be needed to deliver the EUR 4,000. This could look as follows:
The business and the payroll now understands the amount to report and accrue for costs is 10.
These calculations are not straightforward and usually require some expert support because (amongst other things):
Alongside cash globally mobile employees often also receive benefits such housing, medical, education and allowances. They may also continue to participate in pensions etc. in their home country. These benefits may also be taxable in the new country in which they are working so it is necessary to understand what the true cost of delivering these benefits actually is (again, so that right cost accrual can be made). Here again, a net to gross calculation can be prepared to understand the total cost to the employer (inclusive of taxes).
Employees don't expect to pay the tax on assignment benefits or pay tax on compensation that is not taxable in their home location but is in the host. This extra cost usually passes to the employer.
A final common use of net to gross calculations can be in the compensation and benefits area. It can be relevant where employees are moving on a local to local basis. In these examples, the employer or employee has a target net in mind (after taxes) and needs to understand what the gross should be. Again, it’s a sort of backwards calculation.
The different between this and net pay schemes (above) is that no grossing-up is needed as the employee is paying the taxes due themselves.
Net to gross calculations play an important role in cost management and compliance in relation to globally mobile employees.
They can be technically difficult to perform but once done provide important management cost information for the business.
These calculations can be an important input and part of assignment costings which can be used to get approval for an assignment to go ahead from management.
The net to gross calculation establishes which compensation or benefits items are taxable and which are not. This leads to good questions like can similar value to the employee be delivered in a way that isn’t taxable to the employee or perhaps taxable in a more favourable way. This is the starting of tax planning and can be a real game changer from an assignment cost reduction perspective.
Business travellers are a real hot topic in Global Mobility, HR and Tax. As it is a hot topic, it is essential that those involved in employee mobility understand the key issues.
The business will often turn to those handling employee mobility to lead and guide them on how to manage business travellers (whether or not they are formally part of their remit). This is because key to successfully managing the issues is the technical knowledge, process and policy expertise that supports general employee mobility. Those who handle employee mobility may want to consider proactively volunteering to define and co-develop how to manage business travellers. This way, they get to influence and co-design the process and ensure it does not create unnecessary extra process or workloads.
Organisations will have employees who are on assignments, secondments or other forms of structured employee mobility such as commuters or local transfers. The structure that supports these moves will usually result in some compliance steps that assess and manage immigration, payroll, social security and tax obligations. Typically, for these moves someone in the organisation with the right experience and the right knowledge is involved. Business travellers can be very different.
Business travellers are the informal employee mobility in an organisation. This travel happens organically as and when the business requires it. It can range from a single business trip to an ongoing project in a new location or even a change in role where the employee is regularly required to work elsewhere (for example a regional role or an appointment to a Board in another country). These cases are not always managed by those managing the formal mobility in an organisation so this creates real risks for the business.
I would say business travel risks also exist in formal mobility scenarios. I call this the third country workday scenario. For example, say there is an assignees who has been sent to work from the U.K. to South Africa. Due to an opportunity or project the assignee starts to spend time working in Kenya. Kenya is a third country and care is needed to check what compliance obligations there may be there because the structured focus may very well be only on the home and host (UK and South Africa).
This is partially because there is a real focus on this area in payroll audits - a trend that is rapidly gaining momentum globally. Another reason it's topical is because tax and fiscal authority audits are leading to actual fines and reputational damage. Some well-known organisations have been fined in this area in a number of countries.
New ways of working and technology are enabling work anywhere options. With such flexibility comes added risk as where work is physically performed can get disconnected from the country of employment and payroll.
This could easily be a very long list. Overall, it is all about cost, compliance and business disruption.
I usually think about the considerations in three broad buckets.
Tax matters: Is payroll reporting required? Where is social security due - how can dual liabilities be avoided? What tax filings does the employee have to file? Is the employee giving rise to a presence in the other country that could trigger corporate or sales tax obligations? Are business travel and accommodation costs taxable - are there surprise extra costs here?
Legal matters: Does the employee hold the right work permission/ visa to legally work in the new location? Are there any reporting, registration, notification or compensation payment obligations under local rules and the Posted Worker Directive in Europe? Can the employee acquire rights under local labour law - how can this be mitigated?
Operations, welfare and wellbeing: What additional payroll processing and reporting complexity is there - can the systems cope? What disruption to clients and customers and ultimately the business is there if the employee is refused entry or denied departure? Can you quickly identify where employees are in the case of an emergency? Do you know the impact continuous and extended business travel is having on employee wellbeing and welfare?
Technical issues often need bespoke analysis at an individual level across areas like immigration, tax, payroll, tax, employment law and social security. The following are also real hurdles to cross;
Fluidity: The challenge around managing business traveller risks is strongly connected to the fluid nature of those undertaking business travel. A business trip or two can quickly become an extended work period that triggers compliance. If you don’t have reliable start and end dates how you can assess compliance? How do you know a person actually came back and when? There could also be gaps between trips but to assess compliance you have to count all previous trips - how do you get this data?
Ownership: Organisations do not always find the business traveller issue drops nicely into a single function or team remit. This means that cross function communication and collaboration is key to identify owners and stakeholders. This can be a complex and time consuming process.
Reactive approaches: I often hear that organisations don’t feel action is needed because nothing has gone wrong. I would always add ‘...yet’ on the end. The mindset should be around proactively preventing issues rather than mining for issues or waiting to fix them once they’ve occurred. This is a real issue because securing spend to invest in managing the issue is not easy if nothing has ever actually gone wrong...yet.
Data and process: Managing the issues will often have dependencies on good, clean and reliable travel data, collaborative travel providers and systems and good process across jurisdictions. This simply isn’t how the status quo may be - so taking action becomes difficult whilst risk mounts up.
Awareness of the issues and recognition of them is a key first step to managing business traveller risks. Those managing mobility manage similar risks in more structured scenarios so have the expertise to be real leaders in this area and shape how organisations respond.
Some key actions could be:
Shadow payrolls are a key concept for those involved in mobility to become familiar and comfortable with.
They are an essential mechanism through which payroll compliance is delivered. An understanding of why they are used is essential so that those managing mobility can partner with the business to ensure it remains compliant and explain how process will work.
Increasingly, fiscal authorities are very well aware that globally mobile employees receive compensation from a number of sources (which makes compliance more complex) so this is often an area of specific scrutiny in payroll audits.
The scenario that gives rise to a shadow payroll is usually as follows:
Essential to understanding what shadow payrolls are is reflecting upon what role traditional payrolls perform first. A payroll probably performs five key functions:
A shadow payroll is used in a country where there are payroll obligations (B, C and D above) but either no payment is made locally or only part of the overall payment to the employee is made locally. Often no payment is made so is for this reason the terminology 'shadow' is used, it’s not a real payroll as no payment is made but tax reporting and payroll taxes compliance is delivered. Essentially what has happened is we’ve recognised that the physical payment (A above) and the compliance aspects (B,C,D) can be split.
Critical to getting the shadow payroll right is the visibility and flow of global compensation. Globally mobile employees could be being paid by their employer in two countries and often other compensation items are provided by or delivered through third parties (relocation and destination services providers).
The starting point for shadow payroll should be all global compensation (regardless of who paid it and where) and then based on the individual employee tax status some or all of those items may be subject to tax and social security deductions, taxes and reporting.
Shadow payroll delivery can be a highly complex area of mobility support because it requires optimised compensation data flows, cross border tax technical knowledge but also because it is payroll there are often tight deadlines to regularly meet. Often, this support is outsourced by organisations.
I'd love to say it was that simple but the reality is the answer is it is probably required in both locations.
The shadow payroll in the host would be the 'new' payroll but some 'shadow' type adjustments are probably required in the home country too. Let me explain using an example:
To be truly compliant, there is often a need to provide the overall global compensation picture to each country each month to calculate the right payroll taxes due.
The problem is the payroll taxes themselves can actually constitute compensation so there now has to be some method to connect the home and host payrolls. For example the payroll taxes due in host on the shadow payroll are subject to home country social security. This can be a real challenge purely from a data and timing perspective.
Another challenge is the multiple of different sources of compensation -home and host payrolls, home and host expenses and benefits, relocation and destinations services. There has to be a good process to globally accumulate all of this compensation to enable the correct reporting.
Once collated, the compensation has to then be analysed to check what items are subject to tax and social security deductions, taxes and reporting. Often, the answer here is very much dependent on the country combination and the individual tax status of the employee.
I won't go into detail on the next challenge which is grossing up of compensation. This effectively means the shadow payroll has to be operated on basis that the employee is on a net pay scheme so the payroll has to perform net to gross calculations. Often I find this is not a calculation the payroll system was designed for. Therefore, the can be significant complexity at the payroll operational level too.
Shadow payrolls play a very important role in enabling employers to be globally compliant in respect of mobile employees.
Critical success factors to facilitate a good process that doesn't become overly expensive or burdensome are technical know-how, data and process management. If these areas are not addressed, compliance can be a challenge and the burden in terms of workloads for Mobility, HR and Tax professionals can quickly reach unexpected and undesired levels.
Those managing and involved in global mobility will be well aware that employees working in new locations result in changes to compliance obligations for both the employee and the employer. Understanding these changes and managing them is key in managing mobility related risk. Double tax treaties play a role in establishing some criteria that can reduce the complexity and compliance obligations in short term secondments and assignments. As such, an understanding of how they work at a high level is essential. Double taxation treaties are often referred to as Double taxation agreements and tax advisors often also refer to them as DTAs and DTTs.
A Double Tax Treaty is essentially an agreement between two countries which has an overall goal to avoid taxation of the same income twice (double taxation). Double taxation would be an issue for employees since it could significantly alter their net pay after tax and result in significant extra costs for employers. These agreements are also commonly referred to as ‘double tax agreements’ or simply ‘tax treaties’.
Each country has their own tax system and their own tax rules (domestic rules). Tax Treaties sit across the top of these domestic rules and can override them. In addition to eliminating double taxation, tax treaties also facilitate the exchange of information between tax authorities and provide the framework to prevent tax evasion and the resolution of disputes between countries (for example - which country should tax which income or gains when both technically can do so under their domestic rules).
To eliminate double taxation, tax treaties provide different rules for different types of income and receipts such as capital gains. They provide for the allocation of taxing rights between countries. However, tax treaties do not create a tax liability if under the domestic tax law of a country a liability does not exist.
Countries normally use model tax treaties as a framework for negotiating, concluding and revising tax treaties. A model tax treaty is provided by the Organisation for Economic Co-operation and Development (OECD). The model tax treaty is widely used in negotiations by both member and non-member OECD countries.
The countries of the world do not have a uniform tax system. For example, some countries tax income that relates to that country and others tax all income, regardless of where it arises.
As a result, you can have employees who are resident in the country in which they are employed (country 1) but are required to travel to other countries (country 2) to perform work. Those duties in the other country could then be taxable there. The result, there can be taxation on the same income in both countries.
Where there is a tax treaty between the two countries this double taxation could be eliminated provided certain conditions are met. This can result in no income tax in country 2. This is normally only applicable in the course of short periods of work such as projects. Where income tax in country 2 can’t be eliminated (because the conditions are not met) then the same treaties can provide the basis for a tax credit - effectively meaning tax is not paid on the same income twice.
Countries usually need to connect an individual to its tax system before it can tax them - otherwise everyone would be taxable everywhere. Tax residency is usually a key connecting factor - others include nationality or immigration status (as is used by the United States). In cross-border employment scenarios it is not that uncommon that an employee will become resident in two countries. When this happens it is necessary to apply residency tie-breaker rules to determine where the individual is resident in order to apply the provisions of the tax treaty.
Global mobility professionals and those involved in managing cross border employees work require a high level understanding of tax treaties. The rules in those treaties can simplify or reduce compliance in situations where employees are working for a relatively short period in other countries for example less than 183 days (although there are other conditions to be met and exceptions such as Directors and Economic Employers to check).
The key point when managing cross border employees is to work with the business to highlight if managing the employees’ presence in a country as well as the finance set up (which country bears the costs for the employee) can reduce compliance and related costs that often the business would not have built into the overall project.
Human Resources and Mobility professionals can come across employees who have Directorships. These types of employees can very often give rise to different kinds of compliance and reporting obligations. As these employees are often senior, it’s all the more critical to identify payroll and reporting obligations early. The very nature of their roles means their appointments are matters of public record and can be easily uncovered by fiscal and tax authorities. This makes them a particularly risky group of employees.
Often global and multinational groups and businesses operating all over the world, will have local companies or entities in different countries. It is not uncommon that these local entities then have Directors who do not live that country - Non Resident Directors. These Directors are appointed either because HQ wants to retain some oversight and operational control or because they have specific skills and knowledge that are crucial to the successful operation of the business locally.
The key thing here is that exemptions that may apply for normal employees may not work. The commonly known 183 days rule doesn’t always stop payroll or taxation for Directors. Here is why. The basic principle is simple and laid down in Article 16 of the OECD Model Tax Convention (that regulates and influences how countries tax) stating that:
"Directors' fees and other similar payments derived by a resident of a Contracting State in his capacity as a member of the board of directors of a company which is a resident of the other Contracting State may be taxed in that other State."
This means that a director is taxed in the country where the company for whom he performs his Directors duties is situated. Physical presence in that country (by the Director) may not even be required.
In practice however the practical application of the relevant rules vary from this simple starting point. These variations can result from:
In respect of the final point, there is often a misconception that someone who deals with the day-to-day management must be an employee, whereas in practice this is not the case.
To complicate things a little more, there may be a need to establish what compensation relates to specific Directors duties and what compensation relates to general duties performed in the country - the tax / payroll treatment may be different.
As a result, tax technical analysis is recommended to verify the applicable domestic and relevant double tax treaty rules.
It should also be noted that when a non-resident director is taxed in the country where the company is established, it is possible that they will also be taxed in their home county. Double taxation may apply and this will be need to be resolved.
Social security is a key cost and payroll related tax for employees and employers. For social security purposes, contributions in principle need to be paid in the country where the duties are performed.
In the case of non-resident directors, we quickly find situations of simultaneous duties in two or more countries. The question then arises under which social security system the does the director fall?
Within Europe, the cross border social security rules need to be analysed to determine where (in which country) contributions are due.
Other bilateral agreements between countries can also regulate where contributions are due.
However, in case there are no agreements between the countries where the director performs their duties, it is possible that the director (and their employee) will need to pay social security contributions in two (or more) countries. This can result in duplicate costs and additional compliance reporting.
Consideration should also be given to local employment/labour law. A Director may require a specific local form of Directors service agreement that requires specific local clauses or obligations. This should not be overlooked.
Non-resident Directors represent a highly visible but complex class of employee for compliance. They are often senior executives, well compensated and therefore present a high risk.
Most HR and mobility professionals will want to ensure that this class of employee is compliant in all locations they are working. Key to this is understanding the different issues involved and working with the business to ensure they are reviewed with experts and any arrangement is compliant and cost effective.
Crowe Spark, Brussels
When managing and dealing with globally mobile employee there are lots of technical areas to consider - payroll, double taxation, tax equalisation, social security insurances and visas to name only a few. These are commonly in focus in the minds of mobility professionals. Increasingly, knowledge of and compliance with labour law is a very important part of the job too. Non-compliance can lead to penalties or even a ban from working a country. The consequences can be very serious. The posted worker directive is a cross border labour law consideration. As it is a directive, the implementation of it is slightly different at each country level. Local legal and practical knowledge is therefore really key.
Within the EU / EFTA, access to member state markets is a key and fundamental concept. Posting (or sending) of workers from one state to another is major part of this system. If the laws of the country where the work is actually performed would be applicable in every case, company postings to other member states would require knowledge about labour law of many member states. This would in turn hinder companies from realising the benefits of the free market. In order to avoid such difficulties the EU has developed a free movement of workers agreement according to which the regulations of the home country remain applicable in cases of a project/ posting of limited duration in another member state (including EFTA and Switzerland).
Generally, we have to separate local employees from posted workers. A local worker/employee is a mobile worker who enters into an employment agreement in the host country and becomes subject to local labour law and the social security system.
In contrast, a posted worker is an employee sent by his employer to carry out his work in another state for a limited period of time. For example on inter-company assignments or project related work. Based on free movement of workers agreements, posted workers remain under the labour law of the home country and are not governed by the labour law of the host country.
Since member states do have different minimum standards in terms working conditions, this system presents a risk that the posted worker is not on favourable or comparable terms when compared to local workers. A separate issue is that local companies may not able to be compete with foreign companies operating with posted workers because there are vastly different costs or obligations. For that reason the posted worker directive was adopted in 1996 (96/71/EC). In addition, an enforcement directive has been implemented in 2014 and a revision made 2018.
The posted worker directive has the purpose of establishing a legal framework for workers being posted from one state to another state. It contains rules that govern the application of the labour law of the state where the work is carried out. The purpose of the directive is broadly that posted workers are treated comparably when compared to local employees.
The posted worker directive seeks to ensure the local labour market and posted workers’ rights are protected. In practice, this is achieved by requiring the application of the main labour law standards in the host country to posted workers. It mainly covers the following areas:
A worker is posted from a French employer to carry out installation work in Switzerland. Although the French employment contract remains in place, a salary which is comparable to a Swiss market average comparable salary must be paid to the employee. If the salary in the home country is lower, the employee must be compensated for the difference between the French and the Swiss salary.
Every member state has its own set of rules and implementation approach.
To avoid labour law risk, penalties and business disruption, we strongly recommend that businesses take time to review how the posted worked directive has been implemented in the host country. Global Mobility professionals have a key role to play.
It's important to also be aware the different minimum salary rates in various member states are a potentially significant driver of cost which must be evaluated before the posting of a worker; this must be part of the project calculation.
Global Mobility teams have an important role to apply to support their organisation in understanding and applying local regulations and help to avoid unexpected costs and risks associated with projects carried out in other member states.
Curator & Horwath AG
Zurich - St. Gallen
Social security costs differ across Europe so it is vital that mobility professionals understand the basics of the cross border rules that apply so they can help their organisations stay compliant and avoid unnecessary cost, dual contributions and complexity.
Organisations often request employees to work across borders. In some scenarios the cross-border working arises due to the particulars of the employee rather than at the request of the business. For example, the employee may have relocated themselves to a new country but continued in the same role. In these scenarios employer and employee taxes and related payroll need to be reviewed. Social security is a key consideration.
This week we will discuss the social security position in the EU area and the use of the so-called A1 Form. Common rules for what is known as social security coordination apply to EU member states, Iceland, Liechtenstein, Norway and Switzerland. Amongst the main purposes of the rules is the concept that social security contributions should be payable only in one country (at any given time). As a result, dual social security liabilities should be avoided.
The A1 form certifies which country social security rules or legislation (exclusively) apply to the holder of the form. This effectively confirms the country in which social security contributions are due. The form will generally be needed in situations where a person has a connection with more than one EU-country, Iceland, Liechtenstein, Norway and Switzerland.
The A1 Form is based on the rules contained within European Directive (883/2004) that provides the cross border social security coordination rules. This Directive not only deals with rules for employees, but amongst others also for self-employed persons, civil servants, benefit recipients, pilots/cabin crew etc. We will focus on the rules for employees.
Coordination rules that determine which country social security rules and legislation (and therefore social security contributions) apply:
The main rule (and starting point) for employees is that the social security legislation of the country where the work is performed is applicable. In special cases or when an employee works in more than one country, there are exceptions to this rule. I will highlight the most common ones.
If the employee goes to work temporarily in another country, the employer will normally apply for the A1 from the relevant authority/institution in the home country (country where sent from). Employees who normally pursue activities in more than one country, apply for the A1 in the country of residence. When an exception to the normal coordination rules is appropriate, the A1 application is made to the authority/institution in the country where the employee would like to be subject to the legislation. View a full list of competent authorities/institutions. Whenever possible, the application should be made before the duties begin in the other country. The legislation determined as being applicable on the Form A1 is normally binding on all countries. The Form should be retained and made available for presentation to the institutions in the countries the employee is working in.;
The Form A1 confirms the country in which social security is payable. The same form also acts as confirmation that social security is not therefore due in the country in another country the employee is working in. This form is therefore a very important document to retain for payroll audits.In some scenarios the social security legislation applies in a country that is different to the country where the employee is employed and on payroll. In these scenarios, the employer will need to be registered and payroll deductions, payments and reporting will apply. It may well be that taxes (wage / payroll taxes) will have also have to paid (and potentially withheld via the payroll). This would mean that a split or shadow payroll may also have to be implemented. This is a topic for another Mobility Mondays write up.
It’s important for mobility professionals to understand the basic rules that apply in Europe. This understanding will help them ensure payroll compliance and prevent costly dual social security contributions. The rules and how they apply to the UK may change after Brexit.
I often hear organisations talk about how they opt for a commuter role rather than an expat or relocation move because it keeps things simpler.
This expectation however is often misplaced as commuter roles have the potential in some ways to be more complex from a compliance perspective (payroll, tax and social security). It’s important for Mobility / HR and Tax professionals to understand why so they can guide the business accordingly.
Let’s define what we mean by commuter. A commuter is an employee who lives in one country, is employed there but is required to work regularly in another country. There could be a weekly or a monthly pattern but what’s key is they are required to be outside their home country on a regular basis – it’s not just a business trip. No relocation is involved, the family, the family home and payroll remain in the home country.
For many reasons commuter roles have definitely been on the rise in recent years. Some of the key reasons include roles becoming more cross border in nature and the perception that commuter roles are viewed as cost effective alternatives when compared to expat roles. Brexit has been another trigger – presence is required in countries for regulatory reasons but the employee is settled at home (UK) so starts to commute.
To understand why a commuter can be more complex from a compliance perspective we probably need to understand why a typical expat assignment can be less so. In an expat scenario, or even a permanent transfer, there is usually a relocation. That relocation, family and home moving, often means the employee breaks tax residency in the home country. As a result, tax and payroll can over time primarily be a focus in the host country.
Commuters often stay tax resident in the home country – so there is payroll, income tax and social security potentially in both countries. Once worked through, cross-border social security rules can mean the social security is due in one country only but you are then still left with dual payroll and income taxes. The result is payroll gets very complex with specialist knowledge and adjustments being required to prevent double tax withholding and the income tax filings and liabilities for the employee get ever more complex.
The home country employer may also need to register in the host country for social security or payroll taxes. There are also related considerations around immigration, employment law, corporate tax permanent establishment and regulation such as posted worker directives to consider too. If that wasn’t enough to think about, it’s also necessary to check how travel, accommodation and subsistence costs are taxed in both countries. These are very often reimbursed or paid for directly by the employer so if they become taxable there can be hidden tax liabilities that can be unwelcome surprises and costs.
There are solutions and methods to manage the complexities around payroll and taxes but early analysis is absolutely key. This way you can help the business understand the potential changes in obligations that can be triggered. The analysis may also help in identifying the compliance triggers in the host country, for example a certain number of days worked each year. The arrangement can then be structured or managed to either avoid tripping those triggers or at the very least the business is fully aware of what it is signing up for with the related additional complexity and costs.
Mobility and tax professionals will be aware that as employees work across borders they may give rise to changes in compliance obligations such as payroll and income tax filings. What’s not always as well understood is that intra-country mobility can also do the same. Working in different places in the same country can change compliance obligations for the employer. In the UK, we have Scottish Income Tax as an example but the best example of this is probably the USA.
The US Tax and payroll system works in two parts. There is Federal tax as well as State and Local Taxes often referred to as ‘SALT.’ If a domestic employee, or even a globally mobile employee, is working in more than one US city or state it can mean payroll and income taxes to those cities or states are triggered. Employers need a process to monitor where their employees are working to mitigate risk.
Employees working outside of their 'home state' can give rise to payroll related compliance challenges for their employers as well as personally add to their own individual tax compliance burden … with a need to file extra state or city income tax returns. These employees are 'non-resident' because although they work in one state they live in another. As businesses expand, using 'just in time' service delivery methodology and broaden the use of flexible work arrangements, the employers's vulnerability to payroll tax compliance gaps grow.
Well, let's start with the 50 state jurisdictions plus the District of Columbia.D.C. does not tax non-residents and nine states do not impose individual income tax on wages which leaves us with 41 state tax jurisdictions that apply their own sets of rules to non-resident taxation.
The rules then vary from taxation on day one as applied by 24 states … to taxation based on the number of days per individual, the number of days by legal entity or varying wage thresholds to be applied to an employee in a quarter or calendar year. Once you have these rules sorted out, we then have to consider the Reciprocity agreements between certain states to see if there is an overriding agreement that presents taxation to the 'resident' or 'home' state. Now that you get the gist of the rules, or at least how complex they can be – let’s look at implementation.
For a select few sectors that use time and attendance/ timesheet systems (like professional services) then perhaps daily physical work location details are readily available? If so, it’s then a matter of applying the rules for each of your employees. Alternatively, if the physical work location data does not exist, alternatives include employee self-reporting, analysis of preferred or travel suppliers’ data as well as GPS smart phone related apps that can help facilitate the process. Gather the data, apply the tax rules and then integrate with company policies that reflect your corporate culture.
While today’s rules combined with the expanded use of a mobile workforce present payroll tax compliance challenges there are cost effective solutions for employers to mitigate their compliance risk. Another key point is having a solution in place to track employees’ workdays can of course can enable compliance but it can also be proactively used to prevent that same compliance from being triggered.
Note: The Mobile Workforce State Income Tax Simplification Act of 2019 was reintroduced with bipartisan support last week with the aim to universally apply a 30-day taxing threshold for non-residents working outside of their home state. Similar legislation aimed at State Tax Simplification was introduced in 2007, 2009, 2015 and 2017.
View income tax rates in your state [pdf]
For some, this is an area where just the mention of it can start to cause confusion. I am hoping therefore this is a useful write up. First of all, I will mention that often an abbreviated form - just FTC is used. Tax experts often refer to foreign tax credits as ‘FTCs.’
When employees work across borders they may trigger taxation in more than one country – the home as well as the host country (for example). Let’s call home (Country A) and host (Country B). When taxation has been triggered in both countries income tax may become payable in both locations. It is not uncommon that one of the two countries (say Country B) taxes all of the income including the income taxed in Country A. In effect we have what is known as double taxation. Income tax is due on the same income in two different countries. Income tax is due in Country B on everything and in Country A as well (usually on a smaller portion of the income).
Double taxation, of course, would be unfair and would be very costly and demotivating to globally mobile employees. In a number of scenarios, such as where tax equalisation applies, the tax liabilities are transferred to the employer. This double taxation then becomes a potential cost to the employer.
Tax systems recognise that double taxation would be unfair. For example, if Country B charged tax of 25 on income of 50 and then Country A charged tax of 15 (on that same income of 50), then we have total tax of 40 or a tax rate of 80%. In response to this tax systems usually provide some mechanism to remedy this double taxation. One such mechanism is foreign tax credits. Where allowed, a country would compute the tax liability due but then give a “credit” for the tax paid in the other location.
Developing the example we had earlier:
Country B has given a “foreign tax credit” so that the Country B tax due is reduced and double taxation is remedied. It’s not exactly this simple as the workings and calculations are significantly more complex and involved but this illustrates the point,.
Foreign tax credits are quite common in the area of mobility because often tax is driven by economic activity (as one example) and the employee is working in more than one country. Another cause can be compensation that is earned over multiple years – bonuses or equity compensation as examples. The employee may have worked in more than one country during the period to which these earnings relate so more than one country taxes and one of the countries taxes it all.
The double taxation issue can also be very relevant for payroll, after all no employer wants to pay payroll taxes on the same income in more than one country. Tax experts usually find ways of resolving this but it requires detailed knowledge of local and cross border payroll and mobility taxes.
In general, foreign tax credits are usually best left to be managed by tax experts as they can get complex quickly. That said, it is important for those working in the area of mobility to understand they exist. If you are told tax is due in more than one country on the same income, then a fair question is to check how is that resolved. Is a foreign tax credit available? If you are told that there are payroll obligations in two countries it is fair to ask if there are payroll taxes on the same income that will be costly for you as an employer. Again, a fair question is whether a foreign tax credit (or something similar) is available to resolve the double payroll tax?
The foreign tax credit is one of the ways in which double taxation is managed.
There are other methods – exemption for example, but this is not covered here.
Social security is part of the payroll obligations that an employer has and usually consists of an employee and employer component. Like taxes, social security rates differ by country. It’s also important to note that in some countries social security is closely connected to the concept of pension and other related benefits so the ability for the employee to continue to pay into their home country social security system can be a key (and sometimes even an emotive) issue.When an employee from one country is sent to work in another country their compensation can be subject to social security taxes in both countries – so social security is due in the home and the host country (a double cost to the employee and the employer). To eliminate these dual costs a number of countries have signed agreements referred to as social security 'totalisation' agreements. The agreements usually clarify in certain situations the single country in which social security is due and provide a mechanism through which payments made in one country can be recognised in the country.In most agreements, if an employee is sent to work by their employer in another country for up to five years and they continue to be legally employed by the home country employer then home country social security only can be due.
Tax protection is one of a few responses available to employers to help manage the challenge of differing tax and social security rates between countries.
Different countries of course have different tax and social security rates so the net pay to the employee or assignees (after taxes) can change as they work in a new country. This change can become a barrier to mobility from an employee perspective as it adds complexity and uncertainty as well as changing net pay.
We’ve discussed tax equalisation separately- this seeks to neutralise any differences – so the employee is no better or worse off. Tax protection, on the other hand, seeks to “protect” against any increases only. Consequently, the employee can therefore be better off, but should not be worse off (from a tax perspective)
For example, say the tax rate in the home country was 35% but it was 39% in the host country. In this case the employer would effectively settle the 4% extra tax under tax protection. Similarly, if the tax rate in the host was 29% then no employer assistance would be required.
This arrangement is usually deployed by employers where they recognise the tax differences issue, or there is double or multi-country taxation but they don't want apply a tax equalisation approach. In theory, it also allows the employee to benefit from any local country tax breaks which can be an incentive to take up the assignment. Usually, tax protection is part of a gross pay approach (so employee settles the taxes due) and then a reconciliation can be prepared to review if tax protection has in fact been triggered. Sometimes these reconciliations are prepared as standard each year and other employers prefer to have them prepared “on request” (employee has to request or they are prepared for certain employee categories only). Whilst this approach may seem like it is “light touch” from an employer perspective my experience is it can actually get complex quickly. The tax is due by the employee so they usually become very focused on the amount and timing of taxes due
in all locations to understand if they are worse off in any way. As a result, the requirement for line management /HR and expert support can increase.
Different countries have different tax and social security rates. If an employer sends an employee overseas for a work assignment, the new work location may result in different tax rates being applied so the take home pay after taxes could be different.
The purpose of a tax equalisation approach is to neutralise this and ensure that the employee is no better or worse off from a taxes perspective.
The approach usually (but not always) applies to stay at home compensation only. Personal and non-company income is usually (but not always) outside this arrangement.
The administration of the process involves the deduction of an estimated notional/ hypothetical tax from the employee. The actual taxes payable on company compensation then become payable by the employer. The estimated notional/hypothetical tax is then reconciled each year. Tax equalisation approaches enable and promote employee mobility.